Global Market Comments
January 8, 2025
Fiat Lux
2025 Annual Asset Class Review
A Global Vision
FOR PAID SUBSCRIBERS ONLY
Featured Trades:
(SPY), (QQQ), (IWM), (GS), (MS), (JPM), (BAC), (C), (BLK),
(TLT), (TBT), (JNK), (PHB), (HYG), (MUB), (LQD), (FXE), (FXY), (FXB), (FXE), (FXA)
(FCX), (BHP), (RIO), (VALE), (DBA), (DIG), (USO), (DUG), (UNG), (USO),
(XLE), (LNG), (CCJ), (VST), (SMR), (GLD), (DGP), (SLV), (PPTL), (PALL),
(ITB), (LEN), (KBH), (PHM), (DHI)
I am once again writing this report from a first-class sleeping cabin on Amtrak’s legendary California Zephyr.
By day, I have a comfortable seat next to a panoramic window. At night, they fold into two bunk beds, a single and a double. There is a shower, but only Houdini can navigate it.
I am anything but Houdini, so I foray downstairs to use the larger public hot showers. They are divine.
We are now pulling away from Chicago’s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American exceptionalism.
I am headed for Emeryville, California, just across the bay from San Francisco, some 2,121.6 miles away. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure and to keep me up to date with the onboard gossip.
The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Microsoft’s Spellchecker can catch most of the mistakes, but not all of them.
Chicago’s Union Station
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied Internet searches during stops at major stations along the way, like Omaha, Salt Lake City, and Reno, to Google obscure data points and download the latest charts.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS.
Who knew that 95% of America is off the grid? That explains so much about our country today.
I have posted many of my favorite photos from the trip below, although there is only so much you can do from a moving train and an iPhone 16 Pro.
Somewhere in Iowa
The Thumbnail Portfolio
Equities – buy dips, but sell rallies too
Bonds – avoid
Foreign Currencies – avoid
Commodities – avoid
Precious Metals – avoid
Energy – avoid
Real Estate – avoid
1) The Economy – Cooling
I expect a modest 2.0% real GDP growth with a 4.0% inflation rate, giving an unadjusted shrinkage of the economy of negative -2% for 2025. That is down from 0% in in 2024. This may sound discouraging, but believe me, this is the optimistic view. Some of my hedge fund buddies are expecting a zero return over the next four years.
Virtually all independent economists expect the new administration's economic policies will be a drag on both the US and global economies. Trade wars are bad for everyone. When your customers are impoverished, your own business turns south. This is a big deal, since the Magnificent Seven, which accounted for 70% of stock market gains last year, get 60% of their profits from abroad.
The ballooning National Debt is another concern. The last time Trump was in office, he added $10 trillion to the deficit through aggressive tax cuts and spending increases. If this time, he adds another $10-$15 trillion, the National Debt could reach $50 trillion by 2030.
There are two issues here. For a start, Trump will find it a lot harder and more expensive to fund a National Debt at $50 trillion than $20 trillion. Second, borrowing of this unprecedented magnitude, double US GDP, will send interest rates soaring, causing a recession.
The only question then is whether this will be a pandemic-style recession, which took stocks down 30% and recovered quickly, or a 2008 recession which demolished stocks by 52% and dragged on for years.
Hope for the best but expect the worst, unless you want to consider a future career as an Uber driver.
2) Equities – (SPY), (QQQ), (IWM), (GS), (MS), (JPM), (BAC), (C), (BLK)
The outlook for stocks for 2025 is pretty simple. You are going to have to work twice as hard to make half the money you did last year with twice the volatility. You will not be able to be as nowhere near aggressive in 2025 as you were in 2024 It’s a dream scenario for somebody like me. For you, I’m not so sure.
It’s not that US companies aren't growing gangbusters. I expect 2% GDP growth, 15% profit growth, and 12% net margin growth in 2025. But let’s face reality. Stocks are the most expensive they have been in 17 years and we know what happened after 2008. Much of the stock market gain achieved last year was through hefty multiple expansions. This is not good.
Big tech companies might be able to deliver 20% gains and are still the lead sector for the market. Normally that should deliver you a 15%, or $800 gain in the S&P 500 (SPX). We might be able to capture this in the first half of 2025.
Financials will remain the sector with the best risk/reward, and I mean the broader definition of the term, including banks, brokers, money managers, and some small-cap regional banks. The reason is very simple. Their income statements will get juiced at both ends as revenues soar and costs plunge, thanks to deregulation.
No passage of new laws is required to achieve this, just a failure to enforce existing ones. The hint for this is a new SEC chair whose primary interest is promoting the Bitcoin bubble. Buy (GS), (MS), (JPM), (BAC), (C), and (BLK).
However, this is anything but a normal year. Uncertainty is at an eight-year high, thanks to an incoming administration. If the promised policies are delivered, inflation will soar and interest rates will rise, as they already have. We could lose half or all of our stock market gains by the end of 2025.
The big “tell” for this was the awful market performance in December, down 5%. The Dow Average was down ten days in a row for the first time in 70 years. Santa Claus was unceremoniously sent packing. People Are clearly nervous. But then they should be with a bull market that is approaching a decrepit five years in age.
There is a bullish scenario out there and that has Trump doing absolutely nothing in 2025, either because he is unwilling or unable to take action. After all, if the economy isn’t actually broken, why fix it? Better yet, if you own an economy it is better not to break it in the first place.
Nothing substantial can pass Congress with a minuscule one-seat majority in the House of Representatives. There will be no new presidential action through tariffs and only a few token, highly televised deportations, not enough to affect the labor market.
Stocks will not only hold, but they may add to the 15% first-half gains for the year. I give this scenario maybe a 50% probability.
The first indication this is happening is when the presidential characterization of the economy flips in a few months from the world’s worst to the world’s best with no actual change in the numbers. Trump will take all the credit.
You heard it here first.
3) Bonds (TLT), (TBT), (JNK), (PHB), (HYG), (MUB), (LQD)
Amtrak needs to fill every seat in the dining car to get everyone fed on time, so you never know who you will share a table with for breakfast, lunch, or dinner.
There was the Vietnam Vet Phantom Jet Pilot who now refused to fly because he was treated so badly at airports. A young couple desperately eloping from Omaha could only afford seats as far as Salt Lake City. After they sat up all night, I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a “See America Pass.” Mennonites returned home by train because their religion forbade travel by automobiles or airplanes.
The big question to ask here after a 100-basis point rise in bond yields in only three months is whether the (TLT) has suffered enough. The short answer is no, not quite yet, but we’re getting close. Fear of Trump policies should eventually take ten-year US Treasury bond yields to 5.00%, and then we will be ready for a pause at a nine-month bottom. After that, it depends on how history unfolds.
If Trump gets everything he wants, inflation will soar, bonds will crash, and 5.00% will be just a pit stop on the way to 6.00%, 7.00%, and who knows what? On the other hand, if Trump gets nothing he says he wants, then both bonds stocks and bonds will rise, creating a Goldilocks scenario for all balanced portfolios and investors.
That also sets up a sweet spot for entry into (TLT) call spreads close to 5.00% yields. A politician campaigning on one policy, then doing the opposite once elected? Stranger things have happened. The black swans will live.
A Visit to the 19th Century
4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
If your basic assumption for interest rates is that they stay flat or rise, then you have to love the US dollar. Currencies are all about expected interest rate differentials and money always pours into the highest-paying ones. Tariffs will add fat to the fire because any reduction in international trade automatically reduces American trade deficits and is therefore pro-dollar.
This means that you should avoid all foreign currency plays like the plague, including the Euro (FXE), Japanese yen (FXY), British Pound (FXB), Canadian dollar (FXE), and Australian dollar (FXA).
A strong greenback comes with pluses and minuses. It makes our exports expensive and less competitive and therefore creates another drag on the economy. It demolishes traditional weak dollar plays like emerging markets and precious metals. On the other hand, it attracts substantial foreign investments into US stocks and bonds, which has been continuing for the past decade.
Above all, be happy you are paid in US dollars. My foreign clients are getting crushed in an increasingly expensive world.
5) Commodities (FCX), (BHP), (RIO), (VALE), (DBA)
Look at the chart of any commodity stock and you see grim death. Freeport McMoRan (FCX), BHP (BHP), and Rio Tinto (RIO), they’re all the same. They’re all afflicted with the same disease, over-dependence on a robustly growing China, which isn’t growing robustly, if at all.
I firmly believe that this will continue until the current leadership by President Xi Zheng Ping ends. He has spent the last decade globally expanding Chinese interests, engaging in abusive trade practices, hacking, and attacking American allies like Taiwan and the Philippines. You can only wave a red flag in front of the US before it comes back to bite you. A trade war with the US is now imminent.
This will happen sooner than later. The Chinese people don’t like being poor for very long. This is why I didn’t get sucked in on the Chinese long side in the fall, as many hedge funds did.
If China wants to go back to playing nice, as they did in the eighties and nineties, China should return to return to high growth and commodities will look like great “Buys” down here. If they don’t, American growth alone should eventually pull commodities up, as our economy is now growing at a long-term average gross unadjusted 6.00% rate. So the question is how long this takes.
It may pay to start nibbling on the best quality bombed-out names now, like those above.
6) Energy (DIG), (USO), (DUG), (UNG), (USO), (XLE), (LNG), (CCJ), (VST), (SMR)
Energy was one of the worst-performing sectors in the market for the second year in a row and 2025 is looking no better. New supplies are surging, while demand remains stuck in the mud, with the US now producing an incredible 13.5 million barrels a day. OPEC is dead.
EVs now make up 10% of the US auto fleet, and much more in other countries, are making a big dent. Some 50% of all new car sales in China, the world’s largest market, are EVs. The number of barrels of oil needed to increase a unit of American GDP is plunging, as it has done for 25 years, through increased efficiencies. Remember your old Lincoln Continental that used to get eight miles per gallon? Now it gets 27.
Worse yet, a major black swan hovers over the sector. If the Ukraine War somehow ends, some ten million barrels a day of Russian oil will hit the market. Oil prices should plunge to $50 a barrel.
There are always exceptions to the rule, and energy plays not dependent on the price of oil would be a good one. So is natural gas, which will benefit from Cheniere Energy’s (LNG) third export terminal coming online, increasing exports to China. Ukraine cutting off Russian gas flowing to Europe will assure there is plenty of new demand.
But I prefer investing in sectors that have tailwinds and not headwinds. Better leave energy to the pros who have the inside information they need to make money here.
If someone is holding a gun to your head tell you that you MUST invest in energy, go for the new nuclear plays like (CCJ), (VST), and (SMR). We are only at the becoming of the small modular reactor trend, which could accelerate for decades.
7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders.
The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly, that it blew a passenger train over on its side.
In the snow-filled canyons, we saw a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It’s a good omen for the coming year.
We also see countless abandoned 19th-century gold mines and the broken-down wooden trestles leading to huge piles of tailings, relics of previous precious metals booms. So, it is timely here to speak about the future of precious metals.
We certainly got a terrific run on precious metals in 2025, with gold at its highs up 33% and silver up 65%. The miners did even better. Even after the post-election selloff, it was still one of the best-performing asset classes of the year.
But the heat has definitely gone out of this trade. The prospect of higher interest rates for longer in 2025 has sent short-term traders elsewhere. That’s because the opportunity cost of owning precious metals is rising since they pay no interest rates or dividends. And let’s face it, there was definitely new competition for hot money from crypto, which doubled after the election.
The sector is not dead, it is resting. Central bank buying of the barbarous relic continues unabated, especially among sanctioned countries, like Russia and China. Gold is still the principal savings vehicle for many Chinese. They are not going to recover confidence in their own currency, banks, or government anytime soon. And there is still slow but steadily rising industrial demand from solar sectors.
Gold supply has also been falling for years, while costs are rising at least at double the headline inflation rate. So it’s just a matter of time before the supply/demand balance comes back in our favor. Where the final bottom is anyone’s guess as gold lacks the traditional valuation parameters of other asset classes, like dividends or interest paid. We’ll just have to wait for Mr. Market to tell us, who is always right.
Give (GLD), (SLV), (GDX), (GOLD), and (WPM) a rest for now but I’ll be back.
Crossing the Great Nevada Desert Near Area 51
8) Real Estate (ITB), (LEN), (KBH), (PHM), (DHI)
The majestic snow-covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write.
My apologies in advance to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving bands of Indians, itinerant fur traders, the Pony Express, my own immigrant forebearers in wagon trains, the Transcontinental Railroad, the Lincoln Highway, and finally US Interstate 80, which was built for the 1960 Winter Olympics at Squaw Valley, California.
Passing by shantytowns and the forlorn communities of the high desert, I am prompted to comment on the state of the US real estate market.
Real estate was a nice earner for us in 2024 in the new homes sector. The election promptly demolished this trade with the prospect of higher interest rates for longer. Expect this unwelcome drag to continue in 2025.
I am not expecting a housing crash unless interest rates take off. More likely it will continue to grind sideways on low volume. That’s because the market has support from a structural shortage of 10 million homes in the US, the debris left over from the 2008 housing crash. That’s why there is still a Millennial living in your basement. Homebuilders now prioritize profit margins over market share.
I expect this sector to come back someday. New homebuilders have the advantage of offering free upgrades and discounted in-house financing. Avoid for now (DHI), (KBH), (TOL), and (PHM).
9) Postscript
We have pulled into the station at Truckee amid a howling blizzard.
My loyal staff have made the ten-mile trek from my estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been cooling in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
Well, that’s all for now. We’ve just passed what was left of the Pacific mothball fleet moored near the Benicia Bridge (2,000 ships down to six in 80 years). The pressure increase caused by a 7,200-foot descent from Donner Pass has crushed my plastic water bottle. Nice science experiment!
The Golden Gate Bridge and the soaring spire of Salesforce Tower are just coming into view across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my MacBook Pro, iPad, and iPhone, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten-mile night hike up Grizzly Peak tonight and still get home in time to watch the ball drop in New York’s Times Square on TV.
I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I’ll shoot you a Trade Alert whenever I see a window open at a sweet spot on any of the dozens of trades described above, which should be soon.
Good luck and good trading in 2025!
John Thomas
The Mad Hedge Fund Trader
Global Market Comments
April 9, 2024
Fiat Lux
Featured Trade:
(APRIL 23 HAVANA CUBA STRATEGY LUNCHEON)
(My Favorite Passive/Aggressive Portfolio)
(ROM), (UYG), (UCC), (DIG), (BIB)
What if you want to be a little more aggressive with your investment strategy, say twice as aggressive? What if markets don’t deliver any year-on-year change from here?
Then you need a little more pizzazz in your portfolio, and some extra leverage to earn your crust of bread and secure your retirement.
It turns out that I have just the solution for you. This would be my “Passive/Aggressive Portfolio”.
I call it passive in that you just purchase these positions and leave them alone and do not trade them. I call it aggressive as it involves a basket of 2x leveraged ETFs issued by ProShares, based in Bethesda, MD (click here for their link).
The volatility of this portfolio will be higher. But the returns will be double what you would get with an index fund, and possibly much more. It is a “Do not open until 2035” kind of investment strategy.
Here is the makeup of the portfolio:
(ROM) –- ProShares Ultra Technology Fund - The three largest single stock holdings are Apple (AAPL), Microsoft (MSFT), and Facebook (FB). It is up 13.7% so far this year. For more details on the fund, please click here.
(UYG) – ProShares Ultra Financials Fund - The three largest single stock holdings are Wells Fargo (WFC), Berkshire Hathaway (BRK.B), and JP Morgan Chase (JPM). It is up 6.2% so far this year. For more details on the fund, please click here.
(UCC) – ProShares Ultra Consumer Services Fund - The three largest single stock holdings are Amazon (AMZN), (Walt Disney), (DIS), and Home Depot (HD). It is up 18.3% so far this year. For more details on the fund, please click here.
(DIG) -- ProShares Ultra Oil & Gas Fund - The three largest single stock holdings are ExxonMobile (XOM), Chevron (CVX), and Schlumberger (SLB). It is DOWN 38.2% so far this year. For more details on the fund, please click here.
(BIB) – ProShares Ultra NASDAQ Biotechnology Fund – The three largest single stock holdings are Amgen (AMGN), Regeneron (REGN), and Gilead Sciences (GILD). It is up 15% so far this year, but at one point (before the “Sell in May and Go away” I widely advertised) it was up a positively stratospheric 64%. For more details on the fund, please click here.
You can play around with the sector mix at your own discretion. Just focus on the fastest-growing sectors of the US economy, which the Mad Hedge Fund Trader does on a daily basis.
It is tempting to add more leveraged ETFs for sectors like gold (UGL), to act as an additional hedge.
There is also the 2X short Treasury bond fund (TBT), which I have been trading in and out of for years, a bet that long-term bonds will go down, and interest rates rise.
There are a couple of provisos to mention here.
This is NOT a portfolio you want to own going into a recession. So, you will need to exercise some kind of market timing, however occasional.
The good news is that I make more money in bear markets than I do in bull markets because the volatility is so high. However, to benefit from this skill set, you have to keep reading the Diary of a Mad Hedge Fund Trader.
There is also a problem with leveraged ETFs in that management and other fees can be high, dealing spreads wide, and tracking errors huge.
This is why I am limiting the portfolio to 2X ETFs, and avoiding their much more costly and inefficient 3X cousins, which are really only good for intraday trading. The 3X ETFs are really just a broker enrichment vehicle.
There are also going to be certain days when you might want to just go out and watch a long movie, like Gone With the Wind, with an all-ETF portfolio, rather than monitor their performance, no matter how temporary it may be.
A good example was the May 6 2010 flash crash, when the complete absence of liquidity drove all of these funds to huge discounts to their asset values.
Check out the long-term charts, and you can see the damage that was wrought by high-frequency traders on that cataclysmic day, down -53% in the case of the (ROM). Notice that all of these discounts disappeared within hours. It was really just a function of the pricing mechanism being broken.
I have found the portfolio above quite useful when close friends and family members ask me for stock tips for their retirement funds.
It was perfect for my daughter, who won’t be tapping her teacher’s pension accounts for another 30 years when I will be long gone. She mentions her blockbuster returns every time I see her, and she has only been in them for 10 years.
Imagine what technology, financial services, consumer discretionaries, biotechnology, and oil and gas will be worth then? It boggles the mind. My guess is up 100-fold from today’s levels.
You won’t want to put all of your money into a single portfolio like this. But it might be worth carving out 10% of your capital and just leaving it there.
That will certainly be a recommendation for financial advisors besieged with clients complaining about paying high fees.
Adding some spice, and a little leverage to their portfolios might be just the ticket for them.
The Istanbul Spice Market
It’s Time to Spice Up Your Portfolio
Global Market Comments
March 17, 2023
Fiat Lux
Featured Trade:
(OIL ISN’T WHAT IT USED TO BE), (USO), (DIG), (DUG)
(A DIFFERENT VIEW OF THE US)
CLICK HERE to download today's position sheet.
Virtually every analyst has been puzzled by the endless weakness in oil prices (USO), (DIG), (DUG), which have been in a downward spiral for more than a year. Since Russia first invaded Ukraine, the price of Texas tea has collapsed from $132 to $66 a barrel.
In fact, oil ain’t what it used to be.
The first chart below shows the number of barrels of oil needed to generate a unit of GDP, which has been steadily declining for 40 years. The second reveals the percentage of hourly earnings required to buy a gallon of gasoline in the US, which has been mostly flat for three decades, although it has recently started to spike upwards.
The bottom line is that conservation, the rollout of more fuel-efficient vehicles and hybrids, and the growth of alternatives, are all having their desired effect. Notice how small all the new cars on the road are these days, many of which get 40 mpg with conventional gasoline engines.
As for my own household, it has gone all electric. Some 15% or all the new cars sold in the US are EVs, which don’t use oil at all, except for a tiny amount of grease on the wheels and suspension
Developed countries are getting six times more GDP growth per unit of oil than in the past, while emerging economies are getting a fourfold improvement.
The world is gradually weaning itself off of the oil economy. But the operative word here is “gradually”, and it will probably take another two decades before we can bid farewell to Texas tea, at least for transportation purposes.
But the Mileage is Great!
Global Market Comments
January 4, 2023
Fiat Lux
2023 Annual Asset Class Review
A Global Vision
FOR PAID SUBSCRIBERS ONLY
Featured Trades:
(SPX), (QQQ), (IWM) (AAPL), (XLF), (BAC) (JPM), (BAC), (C), (MS), (GS),
(X), (CAT), (DE),(TLT), (TBT), (JNK), (PHB), (HYG), (MUB), (LQD), (FXE), (EUO),
(FXC), (FXA), (YCS), (FXY), (CYB), (DIG), (RIG), (USO), (DUG), (UNG), (USO),
(XLE), (AMLP),(GLD), (DGP), (SLV), (PPTL), (PALL), (ITB), (LEN), (KBH), (PHM)
I am once again writing this report from a first-class sleeping cabin on Amtrak’s legendary California Zephyr.
By day, I have two comfortable seats facing each other next to a panoramic window. At night, they fold into two bunk beds, a single and a double. There is a shower, but only Houdini could navigate it.
I am anything but Houdini, so I foray downstairs to use the larger public hot showers. They are divine.
We are now pulling away from Chicago’s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American exceptionalism.
I am headed for Emeryville, California, just across the bay from San Francisco, some 2,121.6 miles away. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure and to keep me up to date with the onboard gossip.
The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Microsoft’s Spellchecker can catch most of the mistakes, but not all of them.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied Internet searches during stops at major stations along the way to Google obscure data points and download the latest charts.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS.
Who knew that 95% of America is off the grid? That explains so much about our country today.
I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone 14 Pro Max.
Here is the bottom line which I have been warning you about for months. In 2023, we will probably top the 84.63% we made last year, but you are going to have to navigate the reefs, shoals, and hurricanes. Do it and you can laugh all the way to the bank. I will be there to assist you to navigate every step.
The first half of 2023 will be all about trading. After that, I expect markets to go straight up.
And here is my fundamental thesis for 2023. After the Fed kept rates too low for too long, then raised them too much, it will then panic and lower them again too fast to avoid a recession. In other words, a mistake-prone Jay Powell will keep making mistakes. That sounds like a good bet to me.
Let me give you a list of the challenges I see financial markets are facing in the coming year:
The Ten Key Variables for 2023
1) When will the Fed pivot?
2) How much of a toll will the quantitative tightening take?
3) How soon will the Russians give up on Ukraine?
4) When will buyers return to technology stocks from value plays?
5) Will gold replace crypto as the new flight to safety investment?
6) When will the structural commodities boom get a second wind?
7) How fast will the US dollar fall?
8) How quickly will real estate recover?
9) How fast can the Chinese economy bounce back from Covid-19?
10) How far will oil prices keep falling?
The Thumbnail Portfolio
Equities – buy dips
Bonds – sell buy dips
Foreign Currencies – buy dips
Commodities – buy dips
Precious Metals – buy dips
Energy – stand aside
Real Estate – buy dips
1) The Economy – Bouncing Along the Bottom
Whether we get a recession or not, you can count on markets fully discounting one, which it is currently doing with reckless abandon.
Anywhere you look, the data is dire, save for employment, which may be the last shoe to fall. Technology companies seem to be leading us in the right direction with never-ending mass layoffs. Even after relentless cost-cutting though, there are still 1.5 tech job offers per applicant, which is down from last year’s three.
The Fed is currently predicting a weak 0.5% GDP growth rate for 2023, the same feeble rate we saw for 2022. What we might get is two-quarters of negative growth in the first half followed by a sharp snapback in the second half.
Whatever we get, it will be one of the mildest recessions or growth recessions in American economic history. There is no hint of a 2008-style crash. The banking system was shored up too well back then to prevent that. Thank Dodd/Frank.
So far, so good.
2) Equities (SPX), (QQQ), (IWM) (AAPL), (XLF), (BAC) (JPM), (BAC), (C), (MS), (GS), (X), (CAT), (DE)
Since my job is to make your life incredibly easy, I am going to narrow my equity strategy for 2023.
It's all about falling interest rates.
When interest rates are high, as they are now, you only look at trades and investments that can benefit from falling interest rates.
In the first half, that will be value plays like banks, (JPM), (BAC), (C), financials (MS), (GS), homebuilders (KBH), (LEN), (PHM), industrials (X), capital goods (CAT), (DE).
As we come out of any recession in the second half, growth plays will rush to the fore. Big tech will regain leadership and take the group to new all-time highs. That means the volatility and chop we will certainly see in the first half will present a generational opportunity to get into the fastest-growing sectors of the US economy at bargain prices. I’m talking Cadillacs at KIA prices.
A category of its own, Biotech & Healthcare should do well on their own. Not only are they classic defensive plays to hold during a recession, technology and breakthrough new discoveries are hyper-accelerating. My top three picks there are Eli Lily (ELI), Abbvie (ABBV), and Merck (MRK).
Block out time on your calendars because whenever the Volatility Index (VIX) tops $30, I am going pedal to the metal, and full firewall forward (a pilot term), and your inboxes will be flooded with new trade alerts.
There is another equity subclass that we haven’t visited in about a decade, and that would be emerging markets (EEM). After ten years of punishment by a strong dollar, (EEM) has also been forgotten as an investment allocation. We are now in a position where the (EEM) is likely to outperform US markets in 2023, and perhaps for the rest of the decade.
3) Bonds (TLT), (TBT), (JNK), (PHB), (HYG), (MUB), (LQD)
Amtrak needs to fill every seat in the dining car to get everyone fed on time, so you never know who you will share a table with for breakfast, lunch, and dinner.
There was the Vietnam Vet Phantom Jet Pilot who now refused to fly because he was treated so badly at airports. A young couple desperately eloping from Omaha could only afford seats as far as Salt Lake City. After they sat up all night, I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a “See America Pass.” Mennonites are returning home by train because their religion forbade automobiles or airplanes.
The national debt ballooned to an eye-popping $30 trillion in 2021, a gain of an incredible $3 trillion and a post-World War II record. Yet, as long as global central banks are still flooding the money supply with trillions of dollars in liquidity, bonds will not fall in value too dramatically. I’m expecting a slow grind down in prices and up in yields.
The great bond short of 2021 never happened. Even though bonds delivered their worst returns in 19 years, they still remained nearly unchanged. That wasn’t good enough for the many hedge funds, which had to cover massive money-losing shorts into yearend.
Instead, the Great Bond Crash will become a new business. This time, bonds face the gale force headwinds of three promised interest rate hikes. The year-end government bond auctions were a complete disaster.
Fed borrowing continues to balloon out of control. It’s just a matter of time before the last billion dollars in government borrowing breaks the camel’s back.
That makes a bond short a core position in any balanced portfolio. Don’t get lazy. Make sure you only sell a rally lest we get trapped in a range, as we did for most of 2021.
A Visit to the 19th Century
4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
With a major yield advantage over the rest of the world, the US dollar has been on an absolute tear for the past decade. After all, we have the world’s strongest economy.
That is about to end.
If your primary assumption is that US interest rates will see a sharp decline sometime in 2023, then the outlook for the greenback is terrible.
Currencies are driven by interest rate differentials and the buck is soon going to see the fastest shrinking yield premium in the forex markets.
That shines a great bright light on the foreign currency ETFs. You could do well buying the Australian Dollar (FXA), Euro (FXE), Japanese yen (FXE), and British Pound (FXB). I’d pass on the Chinese yuan (CYB) right now until their Covid shutdowns end.
5) Commodities (FCX), (VALE), (DBA)
Commodities are the high beta play in the financial markets. That’s because the cost of being wrong is so much higher. Get on the losing side of commodities and you will be bled dry by storage costs, interest expenses, contangos, and zero demand.
Commodities have one great attribute. They predict recessions earlier than any other asset class. When they peaked in March of 2022, they were screaming loud and clear that a recession would hit in early 2023. By reversing on a dime on October 14, they also told us that the recovery would begin in July of 2023.
You saw this in every important play in the sector, including Broken Hill (BHP), Peabody Energy (BTU), Freeport McMoRan (TCX), and Alcoa Aluminum (AA). Excuse me for using all the old names.
The heady days of the 2011 commodity bubble top are about to replay. Now that this sector is convinced of a substantially weaker US dollar and lower inflation, it is once more a favorite target of traders.
China will still demand prodigious amounts of imported commodities once its pandemic shutdown ends, but not as much as in the past. Much of the country has seen its infrastructure built out, and it is turning from a heavy industrial to a service-based economy, much like the US. Investors are keeping a sharp eye on India as the next major commodity consumer.
And here’s another big new driver. Each electric vehicle requires 200 pounds of copper and production is expected to rise from 1 million units a year to 25 million by 2030. Annual copper production will have to increase three-fold in a decade to accommodate this increase, no easy task, or prices will have to rise.
The great thing about commodities is that it takes a decade to bring new supply online, unlike stocks and bonds, which can merely be created by an entry in an excel spreadsheet. As a result, they always run far higher than you can imagine.
Accumulate all commodities on dips.
6) Energy (DIG), (RIG), (USO), (DUG), (UNG), (XLE), (AMLP)
Energy was the top-performing sector of 2022. But remember, you will be trading an asset class that is eventually on its way to zero sooner than you think. However, you could have several doublings on the way to zero. This is one of those times.
The real tell here is that energy companies are bailing on their own industry. Instead of reinvesting profits back into their future exploration and development, as they have for the last century, they are paying out more in dividends and share buybacks.
Take the money and run.
There is the additional challenge in that the bulk of US investors, especially environmentally friendly ESG funds, are now banned from investing in legacy carbon-based stocks. That means permanently cheap valuations and share prices for the energy industry.
Energy now counts for only 5% of the S&P 500. Twenty years ago, it boasted a 15% weighting.
The gradual shutdown of the industry makes the supply/demand situation infinitely more volatile.
Unless you are a seasoned, peripatetic, sleep-deprived trader, there are better fish to fry.
And guess who the world’s best oil trader was in 2022? That would be the US government, which drew 400 million barrels from the Strategic Petroleum Reserve in Texas and Louisiana at an average price of $90 and now has the option to buy it back at $70, booking a $4 billion paper profit.
The possibility of a huge government bid at $70 will support oil prices for at least early 2023. Whether the Feds execute or not is another question. I’m advising them to hold off until we hit zero again to earn another $18 billion. Why we even have an SPR is beyond me, since America has been a large net energy producer for many years now. Do you think it has something to do with politics?
To understand better how oil might behave in 2023, I’ll be studying US hay consumption from 1900-1920. That was when the horse population fell from 100 million to 6 million, all replaced by gasoline-powered cars and trucks. The internal combustion engine is about to suffer the same fate.
7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders.
The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a passenger train over on its side.
In the snow-filled canyons, we saw a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It’s a good omen for the coming year.
We also see countless abandoned 19th century gold mines and the broken-down wooden trestles leading to huge piles of tailings, relics of previous precious metals booms. So, it is timely here to speak about the future of precious metals.
Fortunately, when a trade isn’t working, I avoid it. That certainly was the case with gold last year.
2022 was a terrible year for precious metals until we got the all-asset class reversal in October. With inflation soaring, stocks volatile, and interest rates soaring, gold had every reason to fall. Instead, it ended up unchanged on the year, thanks to a 15% rally in the last two months.
Bitcoin stole gold’s thunder until a year ago, sucking in all of the speculative interest in the financial system. Jewelry and industrial demand were just not enough to keep gold afloat. That is over now for good and that is why gold is regaining its luster.
Chart formations are starting to look very encouraging with a massive head-and-shoulders bottom in place. So, buy gold on dips if you have a stick of courage on you, which I hope you do.
Higher beta silver (SLV) will be the better bet as it already has been because it plays a major role in the decarbonization of America. There isn’t a solar panel or electric vehicle out there without some silver in them and the growth numbers are positively exponential. Keep buying (SLV), (SLH), and (WPM) on dips.
8) Real Estate (ITB), (LEN), (KBH), (PHM)
The majestic snow-covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write.
My apologies in advance to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebearers in wagon trains, the Transcontinental Railroad, the Lincoln Highway, and finally US Interstate 80, which was built for the 1960 Winter Olympics at Squaw Valley.
Passing by shantytowns and the forlorn communities of the high desert, I am prompted to comment on the state of the US real estate market.
Those in the grip of a real estate recession take solace. We are in the process of unwinding 2022’s excesses, but no more. There is no doubt a long-term bull market in real estate will continue for another decade, once a two year break is completed.
There is a generational structural shortage of supply with housing which won’t come back into balance until the 2030s. You don’t have a real estate crash when we are short 10 million homes.
The reasons, of course, are demographic. There are only three numbers you need to know in the housing market for the next ten years: there are 80 million baby boomers, 65 million Generation Xers who follow them, and 86 million in the generation after that, the Millennials.
The boomers (between ages 58 and 76) have been unloading dwellings to the Gen Xers (between ages 46 and 57) since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. That’s what caused the financial crisis. That has created a massive shortage of housing, both for ownership and rentals.
There is a happy ending to this story.
Millennials now aged 26-41 are now the dominant buyers in the market. They are transitioning from 30% to 70% of all new buyers of homes. They are also just entering the peak spending years of middle age, which is great for everyone.
The Great Millennial Migration to the suburbs and Middle America has just begun. Thanks to the pandemic and Zoom, many are never returning to the cities. That has prompted massive numbers to move from the coasts to the American heartland.
That’s why Boise, Idaho was the top-performing real estate market, followed by Phoenix, Arizona. Personally, I like Reno, Nevada, where Apple, Google, Amazon, and Tesla are building factories as fast as they can.
As a result, the price of single-family homes should continue to rise during the 2020s, as they did during the 1970s and the 1990s when similar demographic forces were at play.
This will happen in the context of a labor shortfall, soaring wages, and rising standards of living.
Rising rents are accelerating this trend. Renters now pay 35% of their gross income, compared to only 18% for owners, and less, when multiple deductions and tax subsidies are considered. Rents are now rising faster than home prices.
Remember, too, that the US will not have built any new houses in large numbers in 16 years. The 50% of small home builders that went under during the Financial Crisis never came back.
We are still operating at only a half of the 2007 peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.
There is a new factor at work. We are all now prisoners of the 2.75% 30-year fixed rate mortgages we all obtained over the past five years. If we sell and try to move, a new mortgage will cost double today. If you borrow at a 2.75% 30-year fixed rate, and the long-term inflation rate is 3%, then, over time, you will get your house for free. That’s why nobody is selling, and prices have barely fallen.
This winds down towards the end of 2023 as the Fed realizes its many errors and sharply lowers interest rates. Home prices will explode…. again.
Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now after you throw in all the tax breaks. It’s also a great inflation play.
That means the major homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) are a buy on the dip.
Recent Reno Real Estate Statistics
9) Postscript
We have pulled into the station at Truckee amid a howling blizzard.
My loyal staff has made the ten-mile trek from my estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
Well, that’s all for now. We’ve just passed what was left of the Pacific mothball fleet moored near the Benicia Bridge (2,000 ships down to six in 50 years). The pressure increase caused by a 7,200-foot descent from Donner Pass has crushed my plastic water bottle. Nice science experiment!
The Golden Gate Bridge and the soaring spire of Salesforce Tower are just around the next bend across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my MacBook Pro and iPhone, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten-mile night hike up Grizzly Peak and still get home in time to watch the ball drop in New York’s Times Square on TV.
I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I’ll shoot you a Trade Alert whenever I see a window open at a sweet spot on any of the dozens of trades described above, which should be soon.
Good luck and good trading in 2023!
John Thomas
The Mad Hedge Fund Trader
Global Market Comments
January 9, 2019
Fiat Lux
2019 Annual Asset Class Review
A Global Vision
FOR PAID SUBSCRIBERS ONLY
Featured Trades:
(SPX), (QQQQ), (XLF), (XLE), (XLI), (XLY),
(TLT), (TBT), (JNK), (PHB), (HYG), (PCY), (MUB), (HCP)
(FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
(FCX), (VALE),
(DIG), (RIG), (USO), (UNG), (USO), (OXY),
(GLD), (GDX), (SLV),
(ITB), (LEN), (KBH), (PHM)
I am once again writing this report from a first-class sleeping cabin on Amtrak’s legendary California Zephyr.
By day, I have two comfortable seats facing each other next to a panoramic window. At night, they fold into two bunk beds, a single and a double. There is a shower, but only Houdini could get to navigate it.
I am not Houdini, so I go downstairs to use the larger public hot showers. They are divine.
We are now pulling away from Chicago’s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American exceptionalism.
I am headed for Emeryville, California, just across the bay from San Francisco, some 2,121.6 miles away. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure and to keep me up to date with the onboard gossip.
The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Microsoft’s Spellchecker can catch most of the mistakes, but not all of them.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied Internet searches during stops at major stations along the way to Google search obscure data points and download the latest charts.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS.
Who knew that 95% of America is off the grid? That explains so much about our country today.
I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone 10x.
After making the rounds with strategists, portfolio managers, and hedge fund traders in the run-up to this trip, I can confirm that 2018 was one of the most brutal to trade for careers lasting 30, 40, or 50 years. This was the year that EVERYTHING went down, the first time that has happened since 1972. Comparisons with 1929, 1987, and 2008 were frequently made.
While my own 23.56% return for last year is the most modest in a decade, it beats the pants off of the Dow Average plunge of 8% and 99.9% of the other managers out there. That is a mere shadow of the spectacular 57.91% profit I took in during 2017. This keeps my ten-year average annualized return at 34.20%.
Our entire fourth-quarter loss came from a single trade, a far too early bet that the Volatility Index would fall from the high of the year at $30.
For a decade, all you had to do was throw a dart at the stock page of the Wall Street Journal and you made money, as long as it didn’t end on retail. No more.
For the first time in years, the passive index funds lost out to the better active managers. The Golden Age of the active manager is over. Most hedge funds did horribly, leveraged long technology stocks and oil and short bonds. None of it worked.
If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:
The Nine Key Variables for 2019
1) Will the Fed raise rates one, two, or three times, or not at all?
2) Will there be a recession this year or will we have to wait for 2020?
3) Is the tax bill fully priced into the economy or is there more stimulus to come?
4) Will the Middle East drag us into a new war?
5) Will technology stocks regain market leadership or will it be replaced by other sectors?
6) Will gold and other commodities finally make a long-awaited comeback?
7) Will rising interest rates (positive) or deficits (negative) drive the US dollar this year?
8) Will oil prices recover in 2019?
9) Will bitcoin ever recover?
Here are your answers to the above: 1) Two, 2) 2020, 3) Yes, 4) No, 5) Both, 6) Yes, 7) Yes, 8) Yes, 9) No.
There you go! That’s all the research you have to do for the coming year. Everything else is a piece of cake. You can go back to your vacation.
The Twelve Highlights of 2018
1) Stocks will finish lower in 2019. However, we aren’t going to collapse from here. We will take one more rush at the all-time highs that will take us up 10% to 15% from current levels, and then fail. That will set up the perfect “head and shoulders” top on the long-term charts that will finally bring to an end this ten-year bull market. This is when you want to sell everything. The May 10, 2019 end to the bull market forecast I made a year ago is looking pretty good.
I think there is a lot to learn from the 1987 example when stocks crashed 20% in a single day, and 42% from their 1987 high, and then rallied for 28 more months until the next S&L crisis-induced recession in 1991.
Investors have just been put through a meat grinder. From here on, its all about trying to get out at a better price, except for the longest-term investors.
2) Stocks will rally from here because they are STILL receiving the greatest amount of stimulus in history. Energy prices have dropped by half, taxes are low, inflation is non-existent, and interest rates are still well below long term averages.
Corporate earnings will grow at a 6% rate, not the 26% we saw in 2018. But growing they are. At current prices, the stock market is assuming that companies will generate big losses in 2019, which they won’t. Just try to find a parking space at a shopping mall anywhere and you’ll see what I mean.
3) Technology stocks will lead any recovery. Love them or hate them, big tech accounts for 25% of stock market capitalization but 50% of US profits. That is where the money is. However, in 2019 they will be joined by biotech and health care companies as market leaders.
4) The next big rally in the market will be triggered by the end of the trade war with China. Don’t expect the US to get much out of the deal. It turns out that the Chinese can handle a 20% plunge in the stock market much better than we can.
5) The Treasury bond market will finally get the next leg down in its new 10-year bear market, but don’t expect Armageddon. The ten-year Treasury yield should hit at least 3.50%, and possibly 4.0%.
6) With slowing, US interest rate rises, the US dollar will have the wind knocked out of it. It’s already begun. The Euro and the Japanese yen will both gain about 10% against the greenback.
7) Political instability is a new unknown factor in making market predictions which most of us have not had to deal with since the Watergate crisis in 1974. It’s hard to imagine the upcoming Mueller Report not generating a large market impact, and presidential tweets are already giving us Dow 1,000-point range days. These are all out of the blue and totally unpredictable.
8) Oil at $42.50 a barrel has also fully discounted a full-on recession. So, if the economic slowdown doesn’t show, we can make it back up to $64 quickly, a 50% gain.
9) Gold continues its slow-motion bull market, gaining another 10% since the August low. It barely delivered in 2018 as a bear market hedge. But once inflation starts to pick up a head of steam, so should the price of the barbarous relic.
10) Commodities had a horrific year, pulled under by the trade war, rising rates, and strong dollar. Reverse all that and they should do better.
11) Residential real estate has been in a bear market since March. You’ll find out for sure if you try to sell your home. Rising interest rates and a slowing economy are not what housing bull markets are made of. However, prices will drop only slightly, like 10%, as there is still a structural shortage of housing in the US.
12) The new tax bill came and went with barely an impact on the economy. At best we got two-quarters of above-average growth and slightly higher capital spending before it returned to a 2%-2.5% mean. Unfortunately, it will cost us $4 trillion in new government debt to achieve this. It was probably the worst value for money spent in American history.
Dow Average 1987-90
The Thumbnail Portfolio
Equities - Go Long. The tenth year of the bull market takes the S&P 500 up 13% from $2,500 to $2,800 during the first half, and then down by more than that in the second half. This sets up the perfect “head and shoulders” top to the entire decade-long move that I have been talking about since the summer.
Technology, Pharmaceuticals, Healthcare, and Biotech will lead on the up moves and now is a great entry point for all of these. Buy low, sell high. Everyone talks about it but few ever actually execute like this.
Bonds - Sell Short. Down for the entire year big time. Sell short every five-point rally in the ten-year Treasury bond. Did I mention that bonds have just had a ten-point rally? That’s why I am doubled up on the short side.
Foreign Currencies - Buy. The US dollar has just ended its five-year bull trend. Any pause in the Fed’s rate rising schedule will send the buck on a swan dive, and it’s looking like we may be about to get a six-month break.
Commodities - Go Long. Global synchronized recovery continues the new bull market.
Precious Metals - Buy. Emerging market central bank demand, accelerating inflation, and a pause in interest rate rises will keep the yellow slowly rising.
Real Estate – Stand Aside. Prices are falling but not enough to make it worth selling your home and buying one back later. A multi-decade demographic tailwind is just starting, and it is just a matter of time before prices come roaring back.
1) The Economy-Slowing
A major $1.5 trillion fiscal stimulus was a terrible idea in the ninth year of an economic recovery with employment at a decade high. Nevertheless, that’s what we got.
The certainty going forward is that the gains provided by lower taxes will be entirely offset by higher interest rates, higher labor costs, and rising commodity and oil prices.
Since most of the benefits accrued to the top 1% of income earners, the proceeds of these breaks entirely ended up share buybacks and the bond market. This is why interest rates are still so incredibly low, even though the Fed has been tightening for 4 ½ years (remember the 2014 taper tantrum?) and raising rates for three years.
And every corporate management views these cuts as temporary so don’t expect any major capital investment or hiring binges based on them.
The trade wars have shifted the global economy from a synchronized recovery to a US only recovery, to a globally-showing one. It turns out that damaging the economies of your biggest economies is bad for your own business. They are also a major weight on US growth. CEOs would rather wait to see how things play out before making ANY long-term decisions.
As a result, I expect real US economic growth will retreat from the 3.0% level of 2018 to a much more modest 1.5%-2.0% range in 2019.
The government shutdown, now in its third week (and second year), will also start to impact 2019 growth estimates. For every two weeks of closure, you can subtract 0.1% in annual growth.
Twenty weeks would cut a full 1%. And if you only have 2% growth to start with that means you don’t have much to throw away until you end up in a full-on recession.
Hyper-accelerating and cross-fertilizing technology will remain a long term and underestimated positive. But you have to live here next to Silicon Valley to realize that.
S&P 500 earnings will grow from the current $170 to $180 at a price earnings multiple at the current 14X, a gain of 6%. Unfortunately, these will start to fade in the second half from the weight of rising interest rates, inflation, and political certainty. Loss of confidence will be a big influence in valuing shares in 2019.
Whatever happened to the $2.5 trillion in offshore funds held by American companies expected to be repatriated back to the US? That was supposed to be a huge market stimulus last year. It’s still sitting out there. It turns out companies still won’t bring the money home even with a lowly 10% tax rate. They’d rather keep it abroad to finance growth there or borrow against it in the US.
Here is the one big impact of the tax bill that everyone is still missing. The 57% of the home-owning population are about to find out how much their loss of local tax deductions and mortgage deductions is going to cost them when they file their 2018 returns in April. They happen to be the country’s biggest spenders. That’s another immeasurable negative for the economy.
Take money out of the pockets of the spenders and give it to the savers and you can’t have anything but a weakening on the economy.
All in all, it will be one of the worst years of the decade for the economy. Maybe that’s what the nightmarish fourth quarter crash was trying to tell us.
2) Equities (SPX), (QQQ), (IWM) (AAPL), (XLF), (BAC)
The final move of a decade long bull market is upon us.
Corporate earnings are at record levels and are climbing at 6% a year. Cash on the balance sheet is at an all-time high as are profit margins. Interest rates are still near historic lows.
Yet, there is not a whiff of inflation anywhere except in now fading home costs and paper asset prices. Almost all other asset classes offer pitiful alternatives.
The golden age of passive index investing is over. This year, portfolio managers are going to have to earn their crust of bread through perfect market timing, sector selection, and individual name-picking. Good luck with that. But then, that’s why you read this newsletter.
I expect an inverse “V”, or Greek lambda type of year. Stocks will rally first, driven by delayed rate rises, a China war settlement, and the end of the government shut down. That will give the Fed the confidence to start raising rates again by mid-year because inflation is finally starting to show. This will deliver another gut-punching market selloff in the second half giving us a negative stock market return for the second year in a row. That hasn’t happened since the Dotcom Bust of 2001-2002.
How much money will I make this year? A lot more than last year’s middling 23.56% because now we have some reliable short selling opportunities for the first time in a decade. Short positions performed dreadfully when global liquidity is expanding. They do much better when it is shrinking, as it is now.
Frozen Headwaters of the Colorado River3) Bonds (TLT), (TBT), (JNK), (PHB), (HYG), (MUB), (LQD)
Amtrak needs to fill every seat in the dining car to get everyone fed, so you never know who you will share a table with for breakfast, lunch, and dinner.
There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate fleeing Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a “See America Pass.” Mennonites returning home by train because their religion forbade automobiles or airplanes.
This year is simply a numbers game for the bond market. The budget deficit should come in at a record $1.2 trillion. The Fed will take out another $600 billion through quantitative tightening. Some $1.8 trillion will be far too much for the bond market to soak up, meaning prices can only fall.
Except that this year is different for the following reasons.
1) The US government is now at war with the world’s largest bond buyer, the Chinese government.
2) A declining US dollar will frighten off foreign buyers to a large degree.
3) The tax cuts have come and gone with no real net benefit to the average American. Probably half of the country saw an actual tax increase from this tax cut, especially me.
All are HUGELY bond negative.
It all adds up to a massive crowding out of individual and corporate borrowers by the federal government, which will be forced to bid up for funds. You are already seeing this in exploding credit spreads. This will be a global problem. There are going to be a heck of a lot of government bonds out there for sale.
That 2.54% yield for the ten-year Treasury bond you saw on your screen in early January? You will laugh at that figure in a year as it hits 3.50% to 4.0%.
Bond investors today get an unbelievably bad deal. If they hang on to the longer maturities, they will get back only 90 cents worth of purchasing power at maturity for every dollar they invest a decade down the road at best.
The only short-term positive for bonds was Fed governor Jay Powell’s statement last week that our central bank will be sensitive to the level of the stock market when considering rate rises. That translates into the reality that rates won’t go up AT ALL as long as markets are in crash mode.
It all means that we are now only two and a half years into a bear market that could last for ten or twenty years.
The IShares 20+ Year Treasury Bond ETF (TLT) trading today at $123 could drop below $100. The 2X ProShares 20+ Short Treasury Bond Fund (TBT) now at $31 is headed for $50 or more.
Junk Bonds (HYG) are already reading the writing on the wall taking a shellacking during the Q4 stock market meltdown. This lackluster return ALWAYS presages an inverted yield curve by a year where short term interest rates are higher than long term ones. This in turn reliably predicts a full-scale recession by 2020 at the latest.
4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
I have pounded away at you for years that interest rate differentials are far and away the biggest decider of the direction in currencies.
This year will prove that concept once again.
With overnight rates now at 2.50% and ten-year Treasury bonds at 2.54%, the US now has the highest interest rates of any major industrialized economy.
However, pause interest rate rises for six months or a year and the dollar loses its mojo very quickly.
Compounding the problem is that a weak dollar begets selling from foreign investors. They are in a mood to do so anyway, as they see rising political instability in the US a burgeoning threat to the value of the greenback.
So the dollar will turn weak against all major currencies, especially the Japanese yen (FXY), and the Australian (FXA) and Canadian (FXC) dollars.
You can take that to the bank.
5) Commodities (FCX), (VALE), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (PHO), (FIW), (CORN), (WEAT), (SOYB), (JJG)
A global synchronized economic slowdown can mean only one thing and that is sustainably lower commodity prices.
Industrial commodities, like copper, iron ore, performed abysmally in 2018, dope slapped by the twin evils of a strong dollar and the China trade war.
We aren’t returning to the heady days of the last commodity bubble top anytime soon. Investors are already front running that move now.
However, once this sector gets the whiff of a weak dollar or higher inflation, it will take off like a scalded chimp.
Now that their infrastructure is largely built out, the Middle Kingdom will change drivers of its economy. This is world-changing.
The shift will be from foreign exports to domestic consumption. This will be a multi-decade process, and they have $3.1 trillion in foreign exchange reserves to finance it.
It will still demand prodigious amounts of imported commodities but not as much as in the past.
This trend ran head-on into a decade-long expansion of capacity by the commodities industry, delivering the five-year bear market that we are only just crawling out of.
The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE) have all been some of the best-performing assets of 2017.
6) Energy (DIG), (RIG), (USO), (DUG), (DIG), (UNG), (USO), (OXY), (XLE), (X)
If you expect a trade war-induced global economic slowdown, the last thing in the world you want to own is an energy investment.
And so it was in Q4 when the price of oil got hammered doing a swan dive from $68 to $42 a barrel, an incredible 38% hickey.
All eyes will be focused on OPEC production looking for new evidence of quota cheating which is slated to expire at the end of 2018. Their latest production cut looked great on paper but proved awful in practice. Welcome to the Middle East.
The only saving grace is that with crude at these subterranean levels, new investment in fracking production has virtually ceased. No matter, US pipelines are operating at full capacity anyway.
OPEC production versus American frackers will create the constant tension in the marketplace for all of 2019.
My argument in favor of commodities and emerging markets applies to Texas tea as well. A weaker US dollar, trade war end, interest rate halt are all big positives for any oil investment. The cure for low oil prices is low prices.
That makes energy Master Limited Partnerships, now yielding 6-10%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.
The Alerian MLP ETF (AMLP) does this for you in an ETF format.
Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system.
Three Burlington Northern engines are heaving to pull over 100 black, spanking brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.
There is another tank car train right behind it. No wonder Warren Buffett tap dances to work every day as he owns the railroad.
We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building.
Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.
As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again. In fact, the coming peak in oil prices may be the last one we ever see. The word is that leasing companies will stop offering five-year leases in five years because cars with internal combustion engines will become worthless in ten.
Add to your long-term portfolio (DIG), ExxonMobile (XOM), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). But date these stocks, don’t marry them.
Skip natural gas (UNG) price plays and only go after volume plays because the discovery of a new 100-year supply from “fracking” and horizontal drilling in shale formations is going to overhang this subsector for a very long time, like the rest of our lives.
It is a basic law of economics that cheaper prices bring greater demand and growing volumes which have to be transported. Any increase in fracking creates more supply of natural gas.
7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders.
The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.
In the snow-filled canyons, we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It’s a good omen for the coming year.
We also see countless abandoned 19th century gold mines and the broken-down wooden trestles leading to them, relics of previous precious metals booms. So, it is timely here to speak about the future of precious metals.
Gold (GLD) lost money in 2018, off 2.4%. More volatile silver (SLV) shed 12%.
This was expected, as non-yielding assets like precious metals do terribly during times of rising interest rates.
In 2019, gold will finally be coming out of a long dark age. As long as the world was clamoring for paper assets like stocks, gold was just another shiny rock. After all, who needs an insurance policy if you are going to live forever?
But the long-term bull case is still there. Gold is not dead; it is just resting.
If you forgot to buy gold at $35, $300, or $800, another entry point here up for those who, so far, have missed the gravy train.
To a certain extent, the belief that high-interest rates are bad for gold is a myth. Wealth creation is a far bigger driver. To see what I mean, take a look at a gold chart for the 1970s when interest rates were rising sharply.
Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.
If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation-adjusted all-time high, or more.
This is why emerging market central banks step in as large buyers every time we probe lower prices. China and India emerged as major buyers of gold in the final quarters of 2018.
They were joined by Russia which was looking for non-dollar investments to dodge US economic and banking sanctions.
That means it’s just a matter of time before gold breaks out to a new multiyear high above $1,300 an ounce. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV) which I think could rise from the present $14 and hit $50 once more, and eventually $100.
The turbocharger for gold will hit sometime in 2019 with the return of inflation. Hello stagflation, it’s been a long time.
8) Real Estate (ITB), (LEN),
The majestic snow-covered Rocky Mountains are behind me. There is now a paucity of scenery with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write.
My apologies in advance to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving bands of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.
Passing by shantytowns and the forlorn communities of the high desert, I am prompted to comment on the state of the US real estate market.
There is no doubt a long-term bull market in real estate is taking a major break. If you didn’t sell your house by March last year you’re screwed and stuck for the duration.
And you’re doubly screwed if you’re trying to sell your home now during the government shutdown. With the IRS closed, tax return transcripts are unobtainable making any loan approval impossible. And no one at Fannie Mae or Freddie Mac, the ultimate buyers of 70% of US home loans, has answered their phone this year.
The good news is that we will not see a 2008 repeat when home values cratered by 50%-70%. There is just not enough leverage in the system to do any real damage. That has gone elsewhere, like in exchange-traded funds. You can thank Dodd/Frank for that which imposed capital rules so strict that it is almost impossible for banks to commit suicide.
And no matter how dire conditions may appear now, you are not going to see serious damage in a market where there is a generational structural shortage of supply.
We are probably seven years into a 17-year run at the next peak in 2028. What we are suffering now is a brief two-year pause to catch our breath. Those bidding wars were getting tiresome anyway.
There are only three numbers you need to know in the housing market for the next 20 years: there are 80 million baby boomers, 65 million Generation Xers who follow them, and 86 million in the generation after that, the Millennials.
The boomers have been unloading dwellings to the Gen Xers since prices peaked in 2007. But there is not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. That’s what caused the financial crisis.
If they have prospered, banks won’t lend to them. Brokers used to say that their market was all about “location, location, location.” Now it is “financing, financing, financing.” Imminent deregulation is about to deep-six that problem.
There is a happy ending to this story.
Millennials now aged 23-38 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market.
The Great Millennial Migration to the suburbs has just begun.
As a result, the price of single-family homes should rocket tenfold during the 2020s as they did during the 1970s and the 1990s when similar demographic forces were at play.
This will happen in the context of a coming labor shortfall, soaring wages, and rising standards of living.
Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.
Remember too that, by then, the US will not have built any new houses in large numbers in 12 years.
We are still operating at only a half of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. And now that it is temporarily a buyer’s market, it is a good time to step in for investment purposes.
You will boast to your grandchildren how little you paid for your house as my grandparents once did to me ($3,000 for a four-bedroom brownstone in Brooklyn in 1922), or I do to my kids ($180,000 for an Upper East Side high rise in 1983).
That means the major homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) may finally be a buy on the dip.
Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.
If you borrow at a 4% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house nearly for free.
How hard is that to figure out?
Crossing the Bridge to Home Sweet Home9) Postscript
We have pulled into the station at Truckee in the midst of a howling blizzard.
My loyal staff has made the ten-mile treck from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
Well, that’s all for now. We’ve just passed the Pacific mothball fleet moored near the Benicia Bridge. The pressure increase caused by a 7,200-foot descent from Donner Pass has crushed my water bottle.
The Golden Gate Bridge and the soaring spire of Salesforce Tower are just around the next bend across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my MacBook Pro and iPhone X, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten-mile night hike up Grizzly Peak and still get home in time to watch the ball drop in New York’s Times Square.
I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I’ll shoot you a Trade Alert whenever I see a window open at a sweet spot on any of the dozens of trades described above.
Good trading in 2019!
John Thomas
The Mad Hedge Fund Trader
